Mervyn King faces a rough ride over UK inflation fears

Fasten your seatbelts. This is going to be a turbulent week for economic
statistics.

On Friday, we will get the official figures for January's retail sales. Although a bounce back is expected after December's snow-depressed figures, we will need to see a few more months' data to get a serious gauge of how well consumers are weathering the storm.

On Wednesday, we may hear that the claimant count of unemployment has edged down a bit. Even so, I expect employment also to have fallen. Again, though, these figures will tell us little, not least because the major squeeze on the public sector is yet to begin.

The big news is due out tomorrow – on inflation. And that will set the scene for the publication of the latest Inflation Report on Wednesday. The story so far is that inflation has consistently surprised on the upside. The MPC has peddled a variety of excuses but they have worn increasingly thin, and the pressure on the Governor and his supporters has continued to build. Last week's figures on producer prices delivered yet another blow. So tomorrow's numbers are going to be much crawled over.

They will be difficult to interpret, as they cover the month when VAT was increased to 20pc. On a mechanical basis, that alone could add as much as 1.5pc to the CPI. In the equivalent month last year, though, VAT was restored to 17.5% from the reduced rate of 15%, which could have added a roughly similar amount to the CPI. That falls out of the annual comparison, so other things equal, inflation could remain the same.

Yet those other things are pesky beasts. Do they ever remain equal? The extent to which retailers have passed on the VAT increase is not known. If they swallowed the increase this year but didn't last year then inflation could fall. Yet this time they may have used the VAT rise to increase underlying prices – or they may have delayed some of the pass through. Or they may even have passed on some of the coming increase in December. We just don't know.

Mind you, there have also been other inflationary factors at work – a 5pc rise in petrol prices and big increases in gas, electricity and food prices. Given all this, I reckon that CPI inflation will rise from 3.7pc to 4.2pc. What's more, even the so-called core measure, which excludes the price of energy, food, alcohol and tobacco (in other words, the cynics say, all the items which normally go up) should also rise to about 3.3pc. The older inflation measures, RPI and RPIX, which are still widely used, may rise to about 5pc.

When will the MPC's misery end? Not yet. I reckon that CPI inflation may well rise for a few months more, and it may even reach 5pc. By the second half of the year, though, the lingering effects of sterling's fall should be fading. Assuming that there are no more sharp rises in oil and commodity prices, and that the coming Budget does not lump on further increases in indirect taxes then, as last year's large monthly rises in the CPI fall out of the annual comparison, inflation should start to fall.

And next January, when this year's VAT rise drops out, it could quickly fall back by about 1pc and could soon fall well below the target, even to the point where the deflationary danger re-emerges.

Wednesday's Inflation Report will give an indication of how far the MPC still believes this story. If the inflation danger is strongly emphasised, and the subsequent fall back in inflation is less pronounced, or thought to be more risky, then this will increase market expectations of imminent rate rises. But I doubt very much that Mervyn King is about to change his tune any time soon. It would not be the first time that the apparent message of the Report was contradicted by the Governor.

Mind you, his is just one vote among nine. So it will be crucial to try to see any signs of a shift by other members. At least this scenario offers prospective re-employment for all those redundant Kremlinologists who used to make a living by interpreting every minute change of utterance or seating plan in the old Soviet Politburo.

I know that this will seem pie in the sky to many readers who are fed up with persistently high inflation – and with the succession of lame excuses – but inflation did indeed plunge in just the way I am forecasting for next year as recently as 2009, and just after it had hit 5.2pc.

Even so, this won't provide much protection for the MPC – or its fellow travellers, like myself – if, as expected, tomorrow's figures are grim. In that case, never mind turbulence for the rest of us, on Wednesday Mervyn King will surely face a very rough ride.